Recording reinvested earnings in balance of payments statistics

Summary

Like any macroeconomic statistics, balance of payments statistics are also prepared in compliance with a set of international methodological standards. These broad conventions ensure the consistency of sectoral statistics (such as balance of payments statistics) with each other and with national accounts, as well as their comparability across countries. One of the most important conventions is accrual-based accounting. With the balance of payments, in particular, this means that the time for recording transactions is linked to the change in ownership of real and financial assets, or the date of the occurrence or extinction of claims and liabilities.

With regard to harmonisation, the Monetary Council of the Magyar Nemzeti Bank decided in September 2002 that it would introduce international methodological principles in two stages starting in 2003 and 2004. 2003 saw a methodological shift with regard to trade in goods, which was followed by changes to income accounting in 2004.

AAs regards accounting for trade in goods in the balance of payments, the MNB abandoned the use of cash accounting data obtained from financial statements by companies and credit institutions, and switched to a method based on customs statistics, which reflects on the actual movement of goods. In customs statistics, transactions are registered at the customs frontier – this feature is in closer harmony both with the accrual-based approach and international practice. (Further information about the changes is available on the MNB’s website at:

From 2004, income on debt has been recorded progressively, replacing the disclosure of actual payments, in the quarterly current account in line with the accrual-based approach.

Similarly, in view of the publication of 2003 data in March 2004, reinvested earnings from direct investment have also been included in the balance of payments statistics compiled by the MNB. This will eliminate the difference (deriving from the absence of reinvested earnings in earlier statistics) between national accounts income and financial accounts on the one hand, and balance of payments statistics, on the other.

TheThe inclusion of reinvested earnings in the balance of payments is a standard requirement in international statistical methodology. In the majority of OECD countries, including the EU Member States, the current practice of recording reinvested earnings is consistent with the principles of international accounting methodology.

Prior to 2004, reinvested earnings were not included in income on direct investment in Hungarian balance of payments statistics. Only dividend payments were recorded in the current account as direct investment income on equity. Moreover, stock data on direct investment were derived by cumulating flow data.

After discussions with the CSO, the MNB introduced its quarterly and annual questionnaire survey of corporate direct investment in 1999.[1] The dissemination of such data is stipulated by the Act on Statistics and implemented as part of the National Data Collection Programme. Apart from recognising reinvested earnings, direct data provision by companies allows for the replacement of stock data, calculated by cumulating flow data, with stock data reported by enterprises.

Revision of the time series according to the new methodology will go back as early as 1995.

This document presents international methodological requirements considered in laying the foundations for the new practice in Hungary. In this context, Appendix 1 compares, through a simplified example, the balance of payments compiled using the old and the new methodologies, and then enumerates the differences. We will also look at the process whereby corporate direct investment questionnaire responses are transformed into data applicable to balance of payments statistics. Since comparable data series have been recalculated going back to 1995, when such questionnaires did not exist, it also describes the method for estimating data from 1995–1998, based on information gathered from corporate tax returns. The study also gives a description of the estimation method used to calculate income data recorded in the balance of payments in a particular year prior to the availability of questionnaire information. Although the primary purpose of the document is to describe the new statistical methodology, some concluding remarks will also be included using new balance of payments and stock data. The remarks are then placed in an international context in Appendix 2.

Recording reinvested earnings will alter the data source and structure of the balance of payments. In addition, the Bank’s practice of data publication and revision will have to be adjusted to the availability of data from direct investment questionnaires, and that of adjusted data from corporate tax returns.

Overall, having analysed the data, it may be concluded that, as a result of the new methodology, the recorded current account deficit is higher over the entire period. This is, first of all, ascribable to the fact that net income accruing to direct investors (after-tax profits), (which, with the registration of reinvested earnings, will be recognised as income on equity) is higher than dividends actually paid recorded so far as income in the current account. Secondly, direct investment in Hungary is far in excess of that by Hungarian residents abroad. Indeed, recording income in accordance with international practice will show a stronger presence of foreign capital in the Hungarian economy in terms of explicit equity investment, insofar as non-resident owners’ income, reinvested into the enterprise based on their decision, is also recorded as an increase in equity. The increase in reinvested earnings is an indication of foreign investors’ positive attitude towards the Hungarian economy – they continuously retain part of their earnings in resident enterprises in addition to the original investment.

Table 1 Changes in the current account due to recording of reinvested earnings

From what has been said above it follows that the importance of disclosing reinvested earnings does not, in effect, lies in accounting for reinvested earnings itself. Rather, it is necessary because it is the only way to account for corporate income in the balance of payments and the related IIP statistics. As long as only dividend payments appeared as income, it was obvious that the income actually earned by direct investment enterprises and hence invested capital were underestimated. (As regards direct investment by residents, this connection does not materialise in actual figures, due to the difference between the currency of recording in earlier statistics and that used in book-keeping. As a result, the effect of recording reinvested earnings is offset by revaluation caused by exchange rate changes. For further details, see subsequent sections.)

From an economic point of view, accounting for reinvested earnings does not affect actual developments in the external equilibrium of the national economy. However, it provides a more accurate picture of the role that foreign direct investment plays in the Hungarian economy, the size of the resulting income and how that income is distributed. The resulting higher current account deficit stems from the nature of recording reinvested earnings. Nevertheless, the higher current account deficit is always financed automatically and, consequently, it does not require additional financing. This also implies that the current account is no longer the only relevant external balance indicator.

Furthermore, the questionnaire-based survey will also change direct investment stock data as compared with the data published so far. Cumulated transaction data, the stock data generated so far, will be replaced by questionnaire data based on corporate balance sheets. Therefore, apart from reinvested earnings, the revision of stock data may also be explained by the replacement of the data source. The values of shares and other equity as well as other investment both in Hungary and abroad will change significantly. As regards equity capital, there will be substantial changes at national levels in stock data for both outward and inward investment.

Table 2 shows stock data for direct investment accounted for using the old and the new methodologies.

Table 2 Stock of FDI equity capital and reinvested earnings as of end-year (Euro million)

Between 1994 and 2003, direct investment by non-residents went up by 500%, while the value of residents’ foreign investment in euro terms surged by 1,500% over the same period. Based on earlier data, growth over the same period was 400% and 1,400%. Valuation of stock data that is consistent with international practice recorded a higher-than-earlier level (cumulated from settlement data) of direct investment in Hungary. The opposite goes for foreign investment by residents – in the new methodology the recorded stock value is lower compared with earlier stocks derived from settlement data. The reason behind that is that the shift to the new questionnaire-based data often resulted in a change of currency used in accounting for investment, and thus changes in the revaluation element of changes in stocks related to exchange rate movements.

Chart 1 Stock of FDI equity capital in Hungary

Chart 2 Stock of FDI equity capital abroad

  1. Recording reinvested earnings in the balance of payments

As a general rule based on international methodological recommendations, the level of income accruing on direct investment in the current account depends solely on the income (which may even be negative) generated in a given year. However, this has nothing to do either with owners’ decisions regarding the amounts of dividends to be paid (which only affects the distribution of income) or actual dividend payments.

Reinvested earnings are calculated as after-tax profit realised in a given year (which may be either positive or negative) less dividends declared payable for the same period. Dividends may not only be approved vis-à-vis profits earned within the given period; consequently, reinvested earnings may even be negative,[2] reflecting the fact that income repatriated from the company has been raised (lowered) by the owners at the expense of equity. (As a result of the accounting technique employed, i.e. the same sum appears with opposite arithmetic sign when accounted as dividends in one hand and as reinvested earnings on the other hand, the income balance remains unaffected by the owners’ decisions concerning the distribution of earnings.)

The income category

International standards define two largely distinct approaches, depending on how corporate income is measured – income may (i) incorporate all components of profit e.g. exchange rate gains and losses, or loss related to the deduction of claims[3] or (ii) exclude such and rely solely on ordinary profits.[4] International methodologies recommend the latter approach.

However, for practical reasons the majority of EU Member States still compile statistics using the former approach, as the accounting-based information available to central banks provides no room for extrapolating the desired elements of profit. For similar reasons, the MNB has adopted the same approach.

Recording income on equity as part of direct investment in the balance of payments statistics requires the following information properly allocated in a given accounting period:

(i) the size of the after-tax profit (or loss) made by the company set up as a direct investment enterprise (ii) the timing and size of dividends declared payable by the investors (iii) the dividend tax payable and (iv) the timing of the actual dividend payment.

The responses given to questions on ‘timing’ help to identify the accounting period i.e. the period in which the transaction in question is to be disclosed in the balance of payments (see numerical example given in Appendix 1). Consequently:

  • Direct investors’ after-tax profit (or loss) must be recorded as reinvested earnings in the balance of payments of the year in which it was actually earned.[5]
  • Dividends must be recorded as an income component in the period in which they are declared payable. Taken together, a clear distinction is made between profit as a benefit of the company’s operation and dividend emerging as a result of the owners’ decision. Dividends declared payable lower reinvested earnings for the given year in the current account and the financial account. Dividend distributed yet unpaid also represents a short-term liability vis-à-vis the investor; therefore, in the financial account of the balance of payments it is accounted for under other capital within direct investment.
  • After investors have distributed after-tax profits, they must pay dividend tax on the dividend declared payable. Since the tax is paid by the enterprise, general government’s claim vis-à-vis the investor is replaced by the enterprise’s claim vis-à-vis the investor in the financial account, as opposed to (tax) revenue recorded as current transfer.
  • When dividend is paid, the actual amount transferred equals dividend declared payable net of dividend tax . Hence, both the liability (arising as a result of the distributed, but unpaid dividend) and the claim vis-à-visthe investor (i.e. dividend tax paid to the general government) becomes extinct. In other words, at the payment stage no current account component exists, the two legs of the transaction only affect the financial account.

Recording corporate after-tax profits as reinvested earnings shows how direct investment affects the current account balance through income account. However, the owners’ decision concerning distribution of income (except for the indirect effect of dividend tax) and the actual payment of dividends have no effect on the current account balance, that is, they do not affect the savings and investment relationship in the national economy.

Balances complying with international recommendations may be drawn up on a yearly basis, following assessment of the questionnaires filled in using corporate balance sheet and profit and loss account data. Data reported with some delay will be replaced by (i) the adoption of balance sheets and profit and loss accounts as the closing event of the business year, or (ii) estimates for corporate profitability and the distribution of income included in statistics released prior to assessment of the information based on such statements.

International practice

Recording reinvested earnings in the balance of payments is a standard requirement in international statistical methodology. The table below shows that in the overwhelming majority of OECD countries, including EU and EMU Member States, the current practice of recording reinvested earnings is consistent with the principles of international methodology.

Distribution of countries in terms of accounting for reinvested earnings

BOPSY = Balance of Payments Statistics Yearbook (IMF)

SIMSDI = Survey of Implementation of Methodological Standards for Direct Investment (OECD, IMF)

  1. The accounting system to be introduced from 2004

In agreement with the CSO, in 1999 the Magyar Nemzeti Bank introduced a questionnaire-based survey to monitor direct investment by resident and non-resident enterprises. The Bank’s intention with the survey was to record reinvested earnings consistent with international statistical methodology. An additional goal was to make available data related to direct investment transactions by non-residents in Hungary and by Hungarian residents abroad on the basis of corporate balance sheets, instead of data aggregated on the basis of transactions. This is the precondition for producing not only direct investment flows for the purposes of statistical analysis, but also to produce stock data in a breakdown by country and sector, and also to be able to record cross-participation[6] consistent with international statistical methodology.[7]

The quarterly questionnaires provide an opportunity (i) to monitor FDI transactions which do not entail cash movement, (ii) to collect more detailed data than settlements data and (iii) to check banks' settlements used to compile balance of payments statistics. The annual questionnaires on stock data, in turn, serve to collect data in full harmony with enterprises’ annual balance sheets and profit and loss accounts, for example, to accurately record the capital stock and to determine the amount of reinvested earnings. As the annual questionnaires are important for recording reinvested earnings and producing stock data, in the following we discuss the relevant aspects.

Based on the responses to the corporate questionnaires, the MNB will release data consistent with international recommendations on Hungary’s balance of payments and the related statistics on the country’s international investment position on 31 March 2004, at the time of releasing the annual data for 2003. The Bank has produced Hungary’s balance of payments and international investment position containing the stock and flow data for direct investment in accordance with the new methodology in a comparable format back to 1995. As, based on the corporate questionnaires on direct investment, data are only available from 1999, the Bank has estimated the relevant data for the period preceding 1999. The Bank has used enterprises’ data from the APEH’s corporate tax return database as well as publicly available information on enterprises quoted on the stock exchange to produce data for direct investment by non-residents in Hungary in the period 1995–1998. For this period,in the absence of other meaningful information, the Bank continues to rely on settlements data produce stock data on direct investment by Hungarian residents abroad.

3.1. Steps of processing questionnaires on direct investment capital

Creating and maintaining registers; defining samples

It is a fundamental issue from the perspective of the entire survey to create and maintain the proper corporate register. From the perspective of direct investment, the most important criterion of determining the range of entities to be monitored[8] is foreign ownership of at least 10% or more of the equity capital.

In choosing the sample within the population, the Bank has included those enterprises in the annual register of foreign direct investment transactions by non-resident investors in Hungary up to 2001, in the registered capital of which the holdings by non-residents amounted to at least HUF 100 million. From 2002, the criterion for choosing the sample has been investors’ equity, instead of registered capital, and the minimum amount of direct holdings has been raised to HUF 300 million. The basis for compiling the register has been the list produced on the basis of corporate tax returns for the year preceding the reference year. The Bank has supplemented this list with the list of enterprises that are not included in the register but have been identified on the basis of bank settlements data used to compile the balance of payments. Each year, some 1800–2000 enterprises are entered into the register.